US regulators press forward with rule that could force foreign banks to flee

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Foreign banks are giving US regulators flak for setting rules about how they operate on domestic soil. Michael S. Gibson, director of the division of banking supervision and regulation at the Federal Reserve, is helping fan the flames. In a speech he gave today, Gibson signalled that US regulators are going to hold international regulators accountable with a new rule that discourages foreign banks from doing business in the US.

The rule stems from the Dodd-Frank financial reform bill, which allows the US to broadly control the activity of foreign banks within its borders. Under the new rule, foreign banks, organized into bank holding companies, would be forced to keep a certain proportion of their capital within the US. That’s a more aggressive policy than what’s required by the international standards of Basel III (which also requires higher capital requirements, but the capital can be anywhere).

Why the US rigidity? American regulators want to be able to wind down all the US operations of a foreign bank at any time (even though a bank’s home country usually handles its bankruptcy). That wasn’t possible when the global financial system was melting down, which made addressing the crisis all the more confusing.

“We believe that the proposal would significantly improve our supervision and regulation of the US operations of foreign banks, help protect US financial stability, and promote competitive equity for all large banking firms operating in the United States,” Gibson testified today.

The downside: the rules could slow down the flow of money globally, stifling competition between global banks. Holding more capital limits banks’ investment opportunities. Holding it in one place is even more restricting. Foreign banks and international regulators argue the rule could drive foreign banks out of the US altogether.

The Swiss bank UBS complained to the Federal Reserve (pdf) on April 30 that the rules would stunt international banking cooperation and undermine “the progress that has been made towards efficient global framework for regulation of the large international financial firms.”

International regulators have taken this a step further, arguing that the rules would stifle competition between multinational banks: “We fear that the [new rules] could spark a protectionist reaction from other jurisdictions, which could ultimately have a substantial negative impact on the global economic recovery,” Michel Barnier, the commissioner responsible for financial services in the European Union, wrote in a letter to the Federal Reserve (pdf) last month.

Despite the slew of complaints, the Fed appears unwilling to back down. In Gibson’s view, the proposal would actually “enhance the ability of the United States, as a host-country regulator, to cooperate with a firm-wide, global resolution of a foreign banking organization led by its home-country authorities.” If the rule persists, no doubt there’s a showdown in store.